There were nearly a million bankruptcy cases filed by individuals and businesses in 2014. It is safe to say that only the tiniest fraction of such debtors have any familiarity with the Supreme Court’s decision in Stern v. Marshall nearly four years ago. (If they do, it almost assuredly is only because the case arose out of the endless litigation between Anna Nicole Smith and the son of her late husband.) Even fewer would be aware of the constitutional issues raised in that case concerning the jurisdiction and authority of the U.S. bankruptcy courts.

Lower courts have been struggling with those issues ever since. Now, based on some of the questions raised in last week’s oral argument in Wellness International Network v. Sharif, it appears that at least some of the justices are realizing the full implications of Stern. The Court’s decision in Wellness International could have significant effects for nearly everyone seeking protection under the U.S. Bankruptcy Code.

If the narrow view of the authority of bankruptcy judges articulated in Stern prevails in Wellness International, bankruptcy judges would be unable to make final rulings on issues as integral to the bankruptcy process as determinations regarding what constitutes property of the bankruptcy estate. If bankruptcy judges’ powers were to be so severely circumscribed, there would be little purpose served by having separate specialized bankruptcy courts. Simply put, the Supreme Court probably must resolve in Wellness International whether a viable system of bankruptcy courts created under Article I of the Constitution can exist in the wake of Stern.

To recap how the Supreme Court got itself to this point:

Under the U.S. Constitution, the “judicial power” of the United States can only be exercised by courts created under Article III. Among other things, judges of Article III courts have lifetime tenure in order to ensure judicial independence. Congress established the U.S. bankruptcy courts pursuant to its power to establish uniform laws on bankruptcy under Article I of the Constitution, rather than under Article III. U.S. bankruptcy judges are appointed for 14 year terms. A line of Supreme Court cases has limited the power of Congress to create courts pursuant to Article I, rather than under Article III, to territorial courts, military tribunals, and courts created to hear cases involving “public rights” (e.g., cases involving claims of citizens against the government). Claims of citizens against one another under state law, such as for breach of contract or common torts, are “private rights” that must be heard by an Article III judge. It had long been believed since the Supreme Court last invalidated the grant of jurisdiction to the bankruptcy courts in 1982 and Congress responded with the Bankruptcy Reform Act of 1984, that disputes pertaining (in the Court’s words) to “the restructuring of debtor-creditor relations, which is at the core of federal bankruptcy power,” constituted the type of “public rights” that could be heard and decided by an Article I bankruptcy judge.

The Supreme Court stunned the commercial legal community in Stern by reopening the question of the constitutionality of the U.S. bankruptcy courts. The Court’s holding in Stern showed that the scope of what constitutes a “public right” susceptible to final determination by an Article I judge is far narrower than previously understood. The Court in Stern described the query for constitutional purposes as “whether the action at issue stems from the bankruptcy itself [i.e., Congress’s bankruptcy power under Article I].” If the matter would exist under state law “without regard to any bankruptcy proceeding,” then it is a “private right” upon which an Article I bankruptcy judge cannot make a final ruling.

The problem created by the Supreme Court’s ruling in Stern is this: the Bankruptcy Code gives the bankruptcy courts power over all property of a debtor’s estate under Section 541(a). Determining what constitutes property of a debtor’s bankruptcy estate is indisputably fundamental to “the restructuring of debtor-creditor relations.” But the Supreme Court has expressly stated in other cases that property rights in bankruptcy are based on state law. State-law issues are an inseparable part of virtually every bankruptcy case. For purposes of determining “public” and “private” rights, which aspect of such adjudications should control?

Wellness International highlights the ramifications of Stern’s cramped view of bankruptcy court authority. The case stems from Sharif’s personal bankruptcy case, which he filed after Wellness International obtained a substantial judgment against him. Wellness International brought an action before the bankruptcy court, challenging Sharif’s claim that certain assets were property of a separate trust and thus excludable from his bankruptcy estate under Section 541(a) of the Bankruptcy Code. The bankruptcy court found in favor of Wellness International, and Sharif appealed. He claimed, among other things, that in the wake of Stern, the bankruptcy court lacked the constitutional authority to enter a final judgment, because the question of ownership of the supposed trust assets was purely an issue of state law, independent of federal bankruptcy law. He also argued that the right to a determination of this issue by an Article III court was not a right that could be waived, not even by a debtor that had expressly sought the jurisdiction of an Article I bankruptcy court by filing a bankruptcy petition. The Seventh Circuit agreed with Sharif on these points and reversed the bankruptcy court ruling.

Last week’s argument showed that at least some of the justices are recognizing the practical consequences of affirming the Seventh Circuit. Justice Breyer, who dissented in Stern, put the question directly to Sharif’s counsel:

This is simply a question of whether a bankruptcy judge can [decide] who owns [certain property], and one party says State law gives them to my cousin Mary and the other party says State law gives them right to you. Now, if we say, no, and side with you on that one, what happens to the constitutional grant to Congress to make uniform laws on bankruptcy? I imagine it would still exist, but I can’t imagine in what form.

The Court has two discreet questions to address in Wellness International: the scope of what constitutes a “public right” in the context of bankruptcy that can be decided by an Article I judge, and whether the right to have a dispute determined by an Article III judge can be waived by consent. Some of the discussion during the oral argument suggests that the Court may look to resolve this case by ruling on only the second question (i.e., finding that Sharif’s voluntary bankruptcy petition constituted consent). However, the Court at some point soon must directly confront and resolve the problems it created by its ruling in Stern, and state once and for all whether our system of specialized bankruptcy courts under Article I can fit within the scope of the “public rights” doctrine.

Ben Feder is special counsel in Kelley Drye & Warren's New York office. He focuses his practice on bankruptcy and restructuring matters. Mr. Feder represents bank lenders, debtors, bondholders, creditors' More

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The firm represents creditors’ committees, debtors, financial institutions, indenture trustees, bondholders, landlords, suppliers and trading partners in out-of-court restructurings, bankruptcy reorganizations, and liquidations and related litigation. Our lawyers are at the forefront in working with clients to develop and execute strategies to maximize recovery, minimize exposure and realize the best business outcome.